There’s been a debate about what to do about banks that are too big to fail, too big to prosecute, and too big to regulate. The debate goes that the big banks should be broken up, and some people are suggesting that the only real solution is public banking – banks that are big in scale but have public interest mandates and are publicly owned.

Now weighing in on this debate and joining us in the studio is Michael Hudson. Michael was a Wall Street financial analyst, and he’s now a distinguished research professor of economics at the University of Missouri-Kansas City. His recent books are The Bubble and Beyond and Finance Capitalism and Its Discontents.

Thanks for joining us again.

MICHAEL HUDSON, RESEARCH PROF., UMKC: Thank you.

JAY: So what’s your take on breaking up the banks vs. public banking?

HUDSON: Well for one thing, in your very first question you left out the point that Elizabeth Warren has made earlier this week: too big to fail means too big to jail.

JAY: I said too big to prosecute, but yeah.

HUDSON: Okay, too big to jail. You heard Attorney General Eric Holder say last week that we can’t prosecute the banks, because they already are so insolvent that we would have to take them over if we fined them. They wouldn’t have any reserves left, after paying the fines proportional to the gains they made by their lawbreaking. We would have to make them into public banks, and that would be socialism.

The fact is that two hundred years ago, when the Industrial Revolution was taking off, bank reformers in England, the Saint-Simonians in France, the “state socialists” in Germany and central Europe all believed that industrial capitalism was going to industrialize and socialize banking in keeping with government and heavy industry in a three-way relationship.

Mr. Holder explained to the Senate Finance Committee just why the government was powerless to protect bank customers against financial fraud and theft in countering Senator Grassley’s questioning:

GRASSLEY: On the issue of bank prosecution, I’m concerned that we have a mentality of too-big-to-jail in the financial sector of spreading from fraud cases to terrorist financing and money laundering cases – and I cite HSBC. So I think we’re on a slippery slope.

HOLDER: The concern that you have raised is one that I, frankly, share. And I’m not talking about HSBC now. That (inaudible) be appropriate.

But I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy. And I think that is a function of the fact that some of these institutions have become too large.Source

It gets even worse than that. Television viewers were appalled when Assistant Attorney General Lanny Breuer was interviewed on Frontline and said that he lay awake at night worrying that if he prosecuted the banks, innocent workers – tellers, loan officers, etc. – as well as the innocent wives, children and families of crooked bankers would suffer, just because bank fraudsters stole hundreds of billions of dollars and threw victimized families into the street. He made it clear that his loyalty was to the predators and had dripping hate for the victims for being weak – and at the same time, lust to return to his high-paying job at law firms defending bankers against the Justice Department.

Regarding the massive multi-billion dollars that HSBC laundered for Mexican drug cartels, Breuer said: “Our goal is not to bring HSBC down. It’s not to cause a systemic effect on the economy.” So here we are throwing up to half the black males in America in jail for typically small-scale drug possession, but the capos at the top – the banks organizing the trade – are allowed to keep functioning. Because the reverse would be socialism.

The public response was so strong that the DoJ had to do something. So it said how much worse the “socialist” response would be. We’d be like Hitler’s Germany or Zimbabwe, and so forth. But that’s not the real antithesis. It’s between bank fraud and drug-dealing on the one hand, and public banking or “socialism” on the other. I can’t think of a better argument for socialism!

The idea by the Progressive Era in the early 20th century was that instead of banking being predatory as it had been for thousands of years, instead lending against real estate or to governments for war loans – or for petty consumer usury, foreclosing and putting people in debtors’ prisons – for the first time in history banks were going to make loans to finance direct investment in new means of production. The aim was to mobilize banking and savings to expand industry, to build factories and equipment that weren’t already there.

This is how Germany rose rapidly to industrial power with the Reichsbank, along with the rest of central Europe. Leading up to World War I, German banks worked with the German government almost as semi public entities – along with the military-industrial complex, to be sure. But at least you had banking taking industrial form.

World War I changed everything. You had a reversion to the English-Dutch-American kind of banking that was called merchant banking. Banks would make loans to ship goods that are already produced, or they’d make loans against real estate. So today you have 80 percent of bank loans in America and England and Scandinavia are all loans for real estate. So, essentially the function of the financial sector has been simply to load down the economy with debt without helping the economy grow.

What you really want is for banks, instead of loading the economy down with debt, to be able to finance economic growth instead of just eating into growth as an overhead.

Well, suppose that the government were to do what Sheila Bair, head of the FDIC, recommended her agency do in 2008. When Citibank went under with what looked like negative equity (and also Bank of America), she said that the FDIC was in the business of taking over banks, as it had just done with WaMu. They could have taken care of the insured depositors, and let the high rollers suffer – as is occurring with the Cyprus bail-in and as the European Central Bank has said it will treat future bank collapses there.

Ms. Bair said that this is not really socialism. It’s what the FDIC and other government agencies are supposed do. When a bank is insolvent, the government takes it over.

Now, imagine what America government, the public sector, could have done with Citibank and Bank of America. These were the two largest mortgage holders in America.

President Obama already had said that his policy was for the banks to write down the mortgages to what people can afford, so that the economy could take off again from a less debt-burdened level. Instead, Citibank refused to write down loans, and Bank of America bought Countrywide Financial – probably the worst offender – and refused to write the loans down. And so what you have now is 10 million Americans in the foreclosure process or already running up arrears as a lead-up to losing their homes. The banks have become the lead participants in a predatory process. So they have become the problem, not the solution. The solution would have been public banking aimed at helping the economy at large rather than bank officers, bondholders and stockholders.

JAY: Isn’t this inevitable? If you go back to the early 20th century when banks started lend money to create new means of production, you see how massive a need there is for this, with big industrialization and tens of thousands of workers in one factory. They need large amounts of capital. As banks become more and more powerful, don’t they then find that it starts to be more profitable to manipulate the stock market and fund speculation? You get this whole period up to the 1929-30 crash where so much banking is parasitic. And then the whole thing replays itself over and over again. Isn’t that inherent that as long as you have private banking become so powerful that it also will be parasitic?

HUDSON: The key word that you just said is “private banking.” So the answer so far, empirically speaking, is “Yes, that’s how it’s working out. That’s the logic of things.”

But it doesn’t have to be this way. If the government would have taken over Citibank it would not have done the kind of things that Citibank did. The government would not have used depositors’ money and borrowed money to gamble. It wouldn’t have gone down the casino capitalism route. It wouldn’t have played the derivatives market. It wouldn’t have made corporate takeover loans. None of these are productive from the vantage point of economic growth and raising productive powers and living standards. They would not be the proper behavior of a public bank.

Suppose the government ran a commercial bank. It would make loans for long-term purposes to serve the economy and help the economy grow. At least, that is what governments are supposed to do.

But that’s not what banks are supposed to do. Banks are supposed to make money. And unfortunately, they can make money most easily – as you point out – by being parasitic, not by being productive.

So if you want banking to play the productive role of financing infrastructure and general economic growth, the only way to do this is for the government to run the banks.

Some recognition of this has come from real estate lobbyists, mainly from Wall Street, saying, “Aha! We need a public-private partnership.” Unfortunately, the kind of partnership that Wall Street envisions is what you got in England under Margaret Thatcher and even worse, Tony Blair. It is an opportunity for the private sector to screw the public sector. That’s what happened earlier when France nationalized the banks a few decades ago. So there need to be reciprocal checks and balances to prevent banks from simply playing the government’s role like a puppeteer in a Punch and Judy show.

JAY: Yeah, the banks make the profit; the public takes the risk.

HUDSON: Yes, its role is to absorb the loss. So this won’t work very well. And it doesn’t really “socialize” the loss, because it’s the opposite of real socialism. It’s financial oligarchy.

A real public-private partnership would leave banks in the hands of the private sector, but behaving much like savings banks used to do – financing specified productive or socially desirable activities, not casino capitalism, corporate takeovers or predatory finance.

The last time that was tried was in the educational loans system, where the government underwrote the education loans made by the banks. And you see the problem now with the defaults there. You would find that in a vaster scale with a public-private partnership organized by Wall Street for its own benefit.

On a deeper level, the problem is that infrastructure shouldn’t be funded by banking. If you fund road building and bridge fixing with a private partnership, then you’re going to have to charge user fees for the use of bridges and charge money for access to the roads. This would threaten to turn America’s roads into toll roads, and turn the bridges into toll bridges. The effect would be to increase the cost of living, and thus increase the cost of doing business, all to squeeze out the revenue for the private investors who are permitted to put up tollbooths at key choke points or access points to these roads. This revenue would be used to pay the banks for the credit they create and lend out to finance the privatization of these roads and bridges. Financializing the economy along these lines would end up cannibalizing the industrial sector. That’s already happening. At the end of this process the U.S. economy would look like England did after Margaret Thatcher and Tony Blair’s New Labour Party crippled the economy with high infrastructure costs. This left Britain only with one pseudo-industry: rogue banking. Its leaders made a mint. They were deregulated, not prosecuted.

Instead of the cartoons that textbooks draw to describe banking under industrial capitalism, we have got something quite different. In the textbook fairy tale, the banker loans money to the industrialist to build a factory. Happy workers are coming in, and deposit their paychecks as savings to make yet more loans to expand the economy.

But what actually is happening today is that Wall Street organizes the sale of high-interest junk bonds to raise money for corporate raiders. The takeover artist buys a factory that’s already there, lays off half the labor force, works the remainder more intensively, takes the pension fund for himself, or uses the Employee Stock Ownership Plan (ESOP) to buy up the company’s stock, so as to raise the price at which he can exercise the stock options he gives himself.

He replaces defined pension benefits with a defined contribution plan, in which all the employees know is how much is docked from their paycheck every month, not what they are going to get after they retire. The role of this kind of “investment banking” is predatory. It makes money from debt-leveraged buyouts, takeover loans, and gambling on which way interest rates or currencies will move.

The effect of this non-industrial superstructure of credit and debt is to shrink employment, worsen working conditions, and downsize pension obligations. Wall Street economists call this “wealth creation,” by which they mean that wealth is being sucked up to the top 1% of the economic pyramid. Wwhen they talk about wealth creation, they mean the wealth to this 1 percent, not prosperity for the 99%.]

JAY: So the rest of the economy gets paralyzed.

HUDSON: As long as this kind of finance is left in private hands, you’re going to have austerity and America will end up looking like Greece and Ireland.

Imagine how different it would have been if the government would have taken over Citibank, Bank of America and other big banks, and announced that these banks henceforth would make loans and extend credit to our own economy to build bridges and roads. This is what China has done to grow, for instance. A government bank wouldn’t have to charge interest – and most important, it could write down loans when they grew too big to pay without pushing the economy into depression. A public bank would not have to pay such high executive salaries. That’s the alternative to permitting high finance to become the ripoff system it’s become today.